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1. Explain comparative cost advantage theory (Ricardian theory of international trade.
2. Critically explain comparative cost advantage theory
3. Explain modern theory/ factor endowment theory/heckscher-ohlin theory of international trade
4. What are terms of trade? Explain factors affecting it
5. Explain terms of trade and its types
6. What is gains of trade and state its importance
7. Critically explain modern theory/factor endowment theory/H-O theory
8. What are the factors affecting gains from trade
9. Explain gains of trade with offer curve.

Q1.Explain the Comparative Advantage Theory of International trade of Ricardo


 According to David Ricardo, it is not the absolute but the comparative difference in
costs that determine trade between two countries. Production costs differ in
countries because of geographical division of labour and specialization in production.
 Due to difference in climate, natural resources, geographical situation and efficiency
of labour, a country can produce one commodity at a lower cost than the other. In
this way, each country specializes in the production of that commodity in which its
comparative cost of production is the least.
 This is the basis of international trade, according to Ricardo. It follows that each
country will specialize in the production of those commodities in which it has the
greatest advantages or the least comparative disadvantages. Thus, a country will
export those commodities in which its comparative advantage is the greatest and
import those commodities in which its comparative disadvantage is the least.

In short ‘ According to comparative cost advantage theory of international theory, each
country exports the commodities in which it has cost advantage and imports that
commodity in which it has cost disadvantage.’

Assumption of the Theory

The Ricardian theory of comparative advantages is based on the following assumption:-
1. There are only two countries in international trade. (India and Nepal)
2. They produce the same two commodities which are same. (Clothe and Shoes)
3. There are similar tastes in both countries.
4. Labour is the only factor of Production. There is no capital factor
5. All units of labour are homogeneous and price of commodities is determined by labour cost
8. Commodities are produced under the law of constant costs or returns.
9. Technological knowledge is unchanged.
10. Factors of production are perfectly mobile within each country, but are perfectly
immobile between countries.


11. There is free trade between the two countries
12. No transport costs are involved in carrying trade between the two countries.
13. All factors of production are fully employed in both the countries.

This theory is explained with the following example:

Country Clothe Shoe
( Labour) ( Labour)
Nepal 10 4
India 20 12
Ratio 10/20=0.5 4/12=0.33

It is observed from the above table that Nepal has advantage in producing both the
commodities i.e. Clothe and Shoe as the labour cost is minimum for both the commodities. In
Nepal, to produce the clothe only 50 percent cost is needed over the cost needed in India.
And to produce Shoe it needs 1/3rd cost of India. So it is able to produce both the
commodities. But in order to take advantage, it will prefer to produce only shoe as the labour
cost is even less than producing clothe. Thus it uses its total labour and produces only shoe
and exports to India. On the other hand India needs 12 labours to produce shoe, but if
imports from Nepal, it is more beneficial. So it prefers producing clothe using its total labour
and exports to Nepal. Thus both gain from the international trade due to cost differences. In
this way international trade takes place between these two countries.

Q2. Criticisms of Ricardian Theory OR Critically explain Comparative Cost advantage
theory OR

1. Unrealistic Assumption of labour Cost:-
The most severe criticism of the comparative advantage doctrine is that it is based on the
labour theory of value. In calculating production labour costs involved in the production
commodities. This is highly unrealistic.

2. No Similar Tastes:-
The assumption of similar tastes is unrealistic because tastes differ with different brackets in
a country. Moreover, they also with the growth on an economy and with the development of
its trade relations with other countries.

3.State Assumption of Fixed Proportions:-
The theory of comparative costs is based on the assumption that labour is used in the same
fixed proportions in the production of all commodities. Moreover, some substitution of
labour for capital is al-ways possible in production.


4. Unrealistic Assumption of Constant Costs:-
The theory is based on another weak assumption that an increase of output due to
international specialization if followed by constant costs. But the fact is that there are either
increasing or diminishing costs.

5. Ignores Transport Costs:-
Ricardo ignores transport costs in determining comparative advantage in trade. This is
highly unrealistic because transport costs play an important role in determining the pattern
of world trade. Like economies of scale, it is an independent factor of production.

6. Factors not Fully Mobile internally:-
The doctrine assumes that factors of production are perfectly mobile internally and wholly
immobile internationally. This is not realistic because even within a country factors do not
move freely from one industry to another or from one region to another.

7. Two-Country Two-Commodity Model Unrealistic:-
The Ricardian model is related to trade between two countries on the basis of two
commodities. This is again unrealistic because in actually, international trade is among many
countries trading in many commodities.

8. Self-Interest Hinders its Operation:-
The doctrine does not operate if a country having a comparative disadvantage does not wish
to import a commodity from the other country due to strategic, military or development

9. Neglects the Role of Technology:-
The theory neglects the role of technological innovations in international trade. This is
unrealistic because technological changes help in increasing the supply of goods not only for
the domestic market but also for international market.

10. One-Sided Theory:-
The Ricardian theory is one-sided because it considers only the supply side of international
trade and neglects the demand side. Whereas demand is also the most influencing factor in
international trade.

11. Impossibility of Complete Specialization:-
Prof. Frank Graham has pointed out that complete specialization will be impossible on the
basis of comparative advantage in producing commodities entering into international trade.

12. Incomplete Theory:-
It is an incomplete theory. It simply explains how two countries gain from international
trade. But it fails to show how the gains from trade are distributed between the two

Q3. Explain Modern theory/Equilibrium theory/Factor endowment theory of Heckscher

H-O theory is also known as Modern theory of international trade. It is advocated by Bertil
Ohlin and it is based on the General Equilibrium theory of Heckscher. So it is known as
Heckscher Ohlin theory of International Trade. It is well known as Factor Endowment
theory or Factor proportion theory because it considers two major factors in its explanation.

According to Ohlin, trade arises due to the differences in the relative prices of different goods
in different nations. The difference in commodity price is due to the difference in their factor
prices (or Costs). Factor is based on the factor endowment in that country. And as the factor
availability is different in the entire nation, there is difference in factor endowment. Thus this
model/ theorem states that

‘ The countries which are rich in labour (Labour intensive) will export labour intensive
goods only and the countries which are rich in capital will export capital intensive
goods only due to their factor endowment (abundance)’

Assumptions of the Theory:

1. There are two countries involved in the international trade. (USA and India)
2. There are two commodities produced by these countries. (Machine and Clothe
3. Both produce labour intensive and capital intensive goods
4. There are two factors of production i.e Capital and Labour
5. There is perfect competition in both commodity and factor markets
6. All production functions are homogeneous.
7. There is constant production to scale.
8. Both the countries differ in factor intensity
9. There is full employment of resources in both and countries
10. There is a free trade and no trade restrictions are observed
11. No transport cost is considered in trade.

Explanation of the theory:

Ohlin says that the country having abundant factor, will product and export goods with it
and will import the goods for which it has scarce resources. Thus it may be labour intensive
or capital intensive. To explain this theory Ohlin has adopted approach of considering factor
prices to know its abundance. But at the same time the abundance of the factors can be
considered in physical terms too.

Let assume that there is a trade between USA and India. Where USA is capital intensive and
India is labour intensive. Therefore, capital is cheap in USA and labour is Cheap in India. So
two commodities are produce i.e.machine and clothe. Machine is capital intensive and clothe
is labour intensive. Both are shown on the Iso-cost line representation the relative prices of
the two factors with possible combinations of the two factors producing a given level of


In USA curve it is seen that 30 capital unit is used with 10 labour units to produce 1 unit of machine. Q4. Thus is it is highly assumptions based which are not realistic. USA will specialize on production of machine by using cheap factor capital extensively while India specializes on commodity Y by using the cheap factor labour available in the country. BHALCHANDRA KARBHARI . Criticism/ Limitation of the H-O theory OR Modern Theory. speaks about only constant returns to scale production. RAJESH BHOITE Page 5 PROF. 1. 4. Thus it is clear that USA is capital intensive and should produce and export Machine whereas India being labour intensive should produce and export Clothe. In fact demand forces are more significant in international trade. One. 30 units are used with 20 labour units to produce 1 unit of clothe. 2. It does not believe in dynamic economy and consider the constant state of the economy with given production function. supply plays an important role in determining the factor price. Thus demand side has been ignored by Ohlin. produces and exports COMPILEDBY DR. Unrealistic assumptions: This theory is based on many unrealistic assumptions like two nations. it assumes no transport cost. Leontief paradox: American economics Leontief tested H-O theory in USA and got surprising result that the country like USA which is more capital intensive. Thus according to Ohlin.In both the diagram. Whereas in India curve. It is more unrealistic today. two commodities and two factors only.sided theory: According to Ohlin. He did not consider the demand factor. the tangent point is E where AB cost line is Equal to Iso-quant IQ. Static in nature: This theorem is static in nature. 3.

So it is the most important term in international economics. 7. less comprehensive. Thus it reveals whether trade is favorable or unfavorable. Haberler’s Criticism: According Haberler. It is true that it basically implies only barter transaction where goods are exchanged for goods. techniques of production etc. The international gain of the trade is known from terms of trade. Thus contradicts H-O gist. It is an analysis of international trade in short. 5. What is terms of trade? Explain its types in detail.  PX refers to the price of Exports  PX refers to the price of Imports When Export price is more – Terms of trade is Favorable When Import price is more -. It shows the relationship between export price and import price. BHALCHANDRA KARBHARI . Other factors ignored: H-O theorem only assumes factor endowment which influences the commodity price and international trade. Wijnhold’s Criticism: According to Economist Wijnhold’s. RAJESH BHOITE Page 6 PROF. Ohlin theory is not based on general equilibrium analysis but it is based on partial equilibrium being incomplete. COMPILEDBY DR.” Terms of trade is expressed as: Terms of Trade = Px/Pm x 100 Where. 6.” According to Hanson “By terms of trade we mean the rate at which one country’s products exchange for those of another. which are the most influencing trade factors. Q5. “Terms of trade are the rate at which the exports are exchanged for imports. labour intensive goods. Terms of trade is Unfavorable. The H-O theory neglects other factors like technology. it is not factor price that determine the costs and commodity prices but it is commodity prices that determine the factor prices. Thus this finding falsifies the H-O theorem. That is why it is called paradox of Leontief. It indicates how many quantities of domestic goods and services (exports) are required to obtain a certain amount of foreign commodities (imports).

If the index of current year is better or greater that of base year. It is also known as the commodity terms of trade.  NBT refers to Net barter terms of trade  PX refers to export price index  PM refers to import price index. It is the superior measure than NBT. The changes in export price and import price over a period of time shows whether terms of trade is favorable or unfavorable. RAJESH BHOITE Page 7 PROF. BHALCHANDRA KARBHARI . It is shown symbolically multiplied by 100. B) Net barter Terms of Trade (NBT): This is the concept which compares the import price index with the export price index.  Tg refers to Gross barter Terms of Trade  Qm refers to Quantity imported  Qx refers to Quantity exported It is also possible to measure the changes in GBT by comparing the current year indices with those of the base year. The ration of this two represents NBT. So in short it is understood that instead of taking into account price index. It is the most popular method used. COMPILEDBY DR. It considers the indices of physical quantities imported and exported rather than considering prices as in commodity terms of trade. Where.Then it’s favorable. quantity indices are taken into consideration for known terms of trade. A) Gross barter Terms of Trade ( GBT): This concept is given by the economist Taussig. Symbolically it is represented as: Where.

This index takes into account the volume of exports of a country and its export and import prices (NBT). This concept not only considers the productivity of factors in the country’s exports but also the productivity of foreign factors in the country’s imports. According to him this is the superior and more useful method of Terms of Trade as it shown real improvement. It is believed that when two commodities are exchanged. It shows import capacity of a nation by considering both the prices as well as physical quantities traded. Dorrance. the factors used for the production of those commodities are exchanged. F) Real Cost Terms of Trade (Tr) It expresses to the total sacrifice of utility involved in the surrender of exports. BHALCHANDRA KARBHARI . Viner which represents the ratio of export price index to the import price index considering changes in the productivity of factors in the production of exports. It is shown symbolically as: D) Single Factoral Terms of Trade: It is introduced by Prof.S. COMPILEDBY DR. It is obtained by multiplying with the index of the amount of disutility per unit of productive resources used in the producing exports. C) Income Terms of Trade(Ty): This measure was introduced by G. E) Double Factoral Terms of Trade: This overcomes the defect of Single Factoral terms of trade. RAJESH BHOITE Page 8 PROF. indirectly.

Size of Population:- Growing population produces serious effects on terms of trade through import and exports. This effects the terms of trade unfavorably. What are the factors affecting Terms of Trade (TOT 1. If the tastes for the products of another country increase. BHALCHANDRA KARBHARI . Because the major part o the production is consumed within the nation. prices will fall relative to its imports. Technological change :- Technological changes also affect the TOT of a country. It will export more than it imports. RAJESH BHOITE Page 9 PROF. and vice versa. Change in Tastes:- Change in testes of the people of a country influence its TOT with another country. its TOT will be unfavorable. Therefore. It is defined as the excess of total utility accruing the imports over the total sacrifice of utility involved in the surrender of exports. their supply will increase. 4. welfare and income. G) Utility Terms of Trade (Tu) The defect of Tr is overcome in Tu. given the taste and technology. Q6. So there is less left for the export. COMPILEDBY DR. 5. it leads to increase in the demand for the imported goods. the TOT will become unfavorable. 2. Economic Growth:- Another factor is economic growth which increases the country’s productivity capacity. If the technological changes lead to the production of more export goods. The benefit from imports must be greater than the sacrifice involved in producing exports. 3. Variety of Products:- A Country that has the potentials of offering a large variety of Products will obviously enjoy favorable terms of trade. Consequently. This is because exports are wide and substantial while the import is negligible. Economic growth affects TOT two ways.

Inflation and Deflation:- Inflation worsens the TOT because with the rise in domestic prices the demand for imports goes up and for export declines. On the other hand. Nature of Goods: If a country is producing and exporting only primary goods and importing manufactured and capital goods. As a result of be imposition of tariff duties. BHALCHANDRA KARBHARI . imports will be reduced in relation to exports and its TOT will improve. a surplus in BOP worsens the TOT by raising the exchange rate of the currency. Q. the gains from international trade refer to the gains from exchange and the gains from specialization based on the general equilibrium analysis.7What is the significance/ Importance of gains of trade? Ans. Introduction:- According to Adam Smith. On the hand. COMPILEDBY DR. it will import less and its TOT will be favourable. Import Substitutes:- If the country produces import-substitute goods in sufficient quantities its import demand for such goods will be low. In modern analysis. 11. the demand for exports increases and for imports falls. the gains from trade resulted from the advantages of division of labour and specialization both at the national and international level. deflation improves the TOT because the prices of domestic goods fall. 8. 10. Tariffs and Quotas:- An import tariff improves the TOT of the tariff-imposing country. As a result. 12. each country would specialize in the production of that commodity which it could produce more cheaply than other countries and import those commodities which it could produce dearly. They were due to the existence of absolute differences in costs. 6. the terms of trade will be unfavorable. For it will sell its goods at a high price in the world market. Market Condition:- A country which has got monopoly or oligopoly in the goods which it exports in the world market is competitive. its TOT will be favorable. that is. 7. RAJESH BHOITE Page 10 PROF. Balance of Payments:- Deficit in BOP brings improvement in TOT because the exchange rate falls. and vice versa.

Links Demand and Supply in different Nations: International trade links demand and supply of product in one country with the supply in another country and benefits both the countries. 2. Division of labour: International trade leads to international specialization. Standard of living improves: International trade increases production and consumption in a country. 5. Increase in output: International trade because of international specialization leads to an increase in the world output of goods and services. Optimum utilization of the resources can be done through it.‘The gains from trade refer to net benefits or increases in goods that a country obtains by trading with other countries. It possesses the necessary natural resources and facilitates for the production of those goods. Employment creation: International trade increases employment opportunities. This leads to international division of labour or international specialization. 6. Specialization in one product becomes possible. 4. 7.’ 1. Import and export of scarce and abundant goods becomes possible this way. It enables a country to specialize in the production of those commodities for which it is bests suited. International trade helps in the equitable distribution of these resources among all the countries of the world. It helps in expansion of trade to the larger extent. COMPILEDBY DR. This leads to increase in national income and thus standard of living of people in the country also improves. RAJESH BHOITE Page 11 PROF. If there is difference in cost of products in two countries then both counties can gain from this cost difference. It is in this way that the prices of factors of production will be equalized between different countries because of international trade. This leans to increase in production in participating countries. Increase in production generates more employment not only in production sector but also in distribution sector. Equal distribution of scarce resources: Some nations are richly endowed with certain natural resources while such resources are scarce in other countries. BHALCHANDRA KARBHARI . 3. Equality in commodity and factor prices: International trade results in the equalization of prices of goods and productive factors in all the countries of the world which enter into international trade.

if and when the traders find that there exists abroad a ratio of prices very different from that to which they are accustomed at home. 7. 1. a country having high demand for foreign goods will have low money incomes.  On the hand. Variety of goods: A country which produces variety of goods. As it will have high demand for foreign goods. Differences in Cost Ratios:- The gains from international trade depend on differences in comparative cost ratios in the two trading countries. The scope of exports is more for such countries. RAJESH BHOITE Page 12 PROF. What are the factors affecting Gains of Trade. Their prices will be high. 2.  As a result. always gains because of supply factor. A country whose goods have a constant demand in other countries will have a high level of money income. its gain from trade will be smaller. Terms of Trade:- The most important factor which determines the gains from trade is the terms of trade. trade.Q8. 6. The size of the gain will depend on the cost of production of each commodity in both countries. The terms of trade refer to the rate at which one commodity of a country is exchanged for another commodity of the country. if a country is technologically backward with abundant labour its volume of foreign trade will be small and so will be its gain from trade. 3. BHALCHANDRA KARBHARI .  COMPILEDBY DR. Level of Income:-  The level of money income of a country is another factor which determines the gains and the share of trade. It lowers costs of production and prices of goods in the home country. “A country gains by foreign trade. A country which exports mainly primary products has unfavorable terms of trade consequently. 4. Nature of Commodities Exported:- Another factor is the nature of commodities exported by a country. 5. Productive Efficiency:  An increase in the productivity efficiency of a county also determines its gain from trade. the other county gains by importing cheap goods and its terms of trade improve but that of the home country deteriorate.its volume of foreign trade will be large and so will be its gain from international. Technological Conditions:-  A country which is technologically advanced and has an abundance of capital.  On the contrary.

Offer curve is explained with the help of following diagram: COMPILEDBY DR.’ The offer cure of a country is based on the relative price of two commodities in that country.In economics and particularly in international trade.  As country which specializes in the production of those commodities in which it enjoys a comparative advantage. Assumptions: 1. Ans. There is specialization and comparative costs advantage. The Offer Curves are also known as ‘Reciprocal demand curve’ or ‘international demand curve’. The offer curve was first derived by English economists Edge worth and Marshall to help explain international trade. an offer curve shows the quantity of one type of product that an agent will export (“Offer”) for each quantity of another type of product that it imports. Size of the Country:-  The gain trade also depends on the size of the country. Two countries and two commodity model is used 2. There is a perfect competition 3. The line has a limit beyond which the offer curve cannot go because. no country will export goods for imports less than what it can produce domestically. BHALCHANDRA KARBHARI .8. It is based on the relative price of the two commodities.It is introduced by Marshall- Edgeworth in geometrical way. exchanges them with a large country. There is free trade and no restrictions 4. All factors are mobile in nature 5. ‘The offer curve of a country denotes the amount of commodity (X) it is willing to offer for a given amount of some other commodity (Y). RAJESH BHOITE Page 13 PROF. Q9 Explain the Gain from trade with offer curve OR Reciprocal Demand Curve or International Demand curve.


What are the WTO agreements TRIPS TRIMS GATS Q. It is the difference between the outflow of funds and inflow of funds (Payment and Receipt). RAJESH BHOITE Page 15 PROF. BHALCHANDRA KARBHARI . What is WTO? Explain its objectives and functions 7. Explain the types of BOP disequilibrium 3. Explain recent trends of BOP 6. Explain causes of BOP disequilibrium 4.profits and Dividends received 3) Interest. 2 – 15 Marks) 1.MODULE –II BOP AND WTO (Que. Therefore it gives true picture of the economy. it is the systematic record of countries economic transaction of foreign trade with the world. Explain the structure of balance of payment 2. It means it does consider not only the merchandise goods but also the services. It includes not only the visible but also invisible goods.1 Explain the structure of Balance of Payments? Balance of Payment is the comprehensive and wider term than BOT. Theoretically it should get balance but practically it does not tally due to the chances of omission and errors According to Charles Kindleberger“ The BOP of a country is a systematic recording of all economic transactions between residents of that country and the rest of the world during a given period of time” The following is the structure of BOP: Receipts Payments 1) Exports of Goods 1) Imports of Goods Trade account balance 2) Exports of services 2) Imports of Services 3) Interest . Explain measures to correct BOP disequilibrium 5. profits and Dividends paid 4) Unilateral receipts 4) Unilateral Payments Current Account Balance (1 to 4) 5) Foreign Investments 5) Investments Abroad 6) Short term Borrowings 6) Short term Lending 7) Medium and long term borrowings 7) Medium and Long term Lending Capital Account Balance (5 to 7) 8) Errors and Omissions 8) Errors and Omissions 9) Change in Reserves (+) 9) Change in Reserves (-) Total Receipts = Total Payments COMPILEDBY DR.

Unilateral trade is consisting of Foreign aid. whereas. there will be trade deficit. there is a corresponding credit.The main elements of Balance of Payments are: 1) Trade Balance: It is the difference between export and import of merchandise goods. The trade balance forms a part of current account. BOP surplus take place when the total credits (receipts) are more than debits (payments). The imbalance can be surplus or deficit. RAJESH BHOITE Page 16 PROF. The surplus BOP may create a good situation for the country. and deficit will take place when the total credits are less than the debits. The credit side includes the official sales of gold abroad. The capital account involves inflow and outflows relating to investments. If the exports are more than imports. there should be a balance in BOP as well i.e. deficit will create an COMPILEDBY DR. There can be either surplus or deficit in current account. profits.. there will be trade surplus. interest. The current account includes export of services. The debit side includes the purchase of gold from abroad and official purchase of foreign currencies. short term borrowings/ lending.2 Discuss the types of disequilibrium of Balance of Payments Ans: Disequilibrium refers to imbalance in the balance of payments. and medium term to long term borrowings/ lending. a balance between both the debit side and credit side. 3) Capital Account Balance: It is the difference between the receipts and payments on account of capital account. and therefore. Gifts and pension. 2) Current Account Balance: It is difference between the receipts and payments on account of current account which includes trade balance. Q. dividends and unilateral payments abroad. The double entry book keeping principle states that for every credit. 5) Errors and Omission: From an accounting point of view. BHALCHANDRA KARBHARI . the BOP always balances on account of the concept of double entry booking system. 4) Foreign Exchange Reserve: It includes the official reserves sold and purchased. and official sales of foreign currencies abroad. and if imports are more than exports.

the term “Disequilibrium” is interpreted from a negative angle. It is justifies as they do not pose a serious threat. earthquake. It is the result of discrepancy in savings and investments. Long term disequilibrium: When the disequilibrium is persistent and long run oriented. It does not pose a serious threat as it can be overcome within a short run. but need huge investments. Such changes may affect import export and thereby the balance of payment position. recession etc. It indicates persistent adverse balance of trade. Fundamental Disequilibrium: The concept of it was originally introduced by International Monetary Fund (IMF). In order to manage with the domestic COMPILEDBY DR. it may disturb terms of trade and cause disequilibrium in BOP. large inflow of capital and the subsequent adverse BOP.adverse affect on the economy. 5. 2) Natural calamities: Natural disasters like flood. In other words it is a long run problem. It is observed in poor nations because they do not have habit of savings. It arises when disequilibrium turns chronic. Trade cycles are not same for all the countries. When a country goes for borrowing or lending it leads to short run disequilibrium. Changes in fashion. say one year is called short run disequilibrium. What are the causes of Balance of Payment disequilibrium? 1) Growing population: It is the unique feature of LDCs (less developed countries). Q3. it implies deficit in BOP. it is called long run disequilibrium. 3. and therefore. boom. Due to ever increasing population. Fundamental disequilibrium appears mainly on account of persistent deficit. It results in BOP disequilibrium. If this gap is not filled by the foreign flows then it results in the long run disequilibrium. It is the extension of short run disequilibrium. 2. It may be caused due to international borrowing and lending. It is the combinations of the short run Disequilibrium. Cyclical Disequilibrium:When disequilibrium is caused due to changes in trade cycles. Short run disequilibrium: Disequilibrium caused on a temporary basis for a shorts period. Types: 1. RAJESH BHOITE Page 17 PROF. It is possible that different phases of trade cycle like depression. to feed those need nation has to import more with no exports. Structural disequilibrium: It may also be caused by structural changes in the economy. tastes etc. 4. Normally. A war situation may also result in structural changes causing BOP disequilibrium. storms etc. maybring changes in demand and supply conditions. BHALCHANDRA KARBHARI .prosperity. Even the change in taste for foreign goods may increase imports. destroy agriculture and brings food crisis in the nation. demand for consumption increases. Arrival of substitutes in the importing countries may seriously threaten the exporting countries. it is termed as cyclical disequilibrium.

5) Demonstration effect: Due to globalization and open economy. This imitation to foreign nations in consumption pattern reduces exports and increases imports. BHALCHANDRA KARBHARI . This reduces exports also and affects in BOP deficit. RAJESH BHOITE Page 18 PROF. 4) Repayment of debts and interest: LDC’s nations take loans or financial assistance from other nations. Demand for goods of MNC’s is on the height and imparted items have become common. free flow of goods and services is restricted. Also It increases their domestic consumption so export surplus becomes less. It increases payment side of BOP statement. It results in fewer exports and more imports affecting BOP disequilibrium. Q. They have to pay interest thereon regularly. resulting in a deficit balance of payments. This all affect BOP position of the nation. It also brings BOP disequilibrium. So increased income reduces surplus but increases deficit causing BOP deficit. Their propensity to import goes on increasing for want of capital for rapid industrialization. Putting restriction like quota.4) Explain the methods of correction of disequilibrium in Balance of Payments. 7) Trade barriers: Many countries impose tariff and non-tariff barriers to restrict free trade. the nation has to depend on imports. IDA etc are paid by them. while exports may not be boosted up to that extent as these is the primary producing countries. 8)High developmental and Investment programmes: Huge development and investments programmes in the developing economies are root causes of the disequilibrium in the balance of Payments of these countries. 6) Inflation: Rapidly rising prices is common issue in almost all the countries but it is particularly grave in the developing economies. A rise in the comparative price level certainly encourages imports and discourages exports. 3) Increase in income: With rise in income of the people. Even the repayments of old debt taken from IMF or WORD BANK.demand of goods and services. their purchasing power also increases for the foreign or imported goods. It adversely affects BOP position. Due to inflation they become good to sell in but bad to buy from. It brings effects on the composition of exports and imports resulting in BOP disequilibrium. today people have started copying or imitating west. COMPILEDBY DR. tariff barriers.

it will appreciate. Under fixed exchange rate system.  When the country faces the problem of foreign exchange. demand for and supply of foreign currency. and imports will become expensive. B) NON-MONETARY MEASURES 1. This can be done through devaluation of the domestic currency. Deflation: The wages and salaries are lowered to cut the purchasing power of the people. 3.  The exchange rate gets adjusted depending upon market forces. When inflation reduces. RAJESH BHOITE Page 19 PROF. This in turn will help to reduce imports and increase exports. Depreciation:In  Under flexible exchange rate system. export increases and import gets reduced which helps to correct BOP position. and vise-versa. the exports will become cheaper. It refers to the automatic way by which the value of currency gets reduced by the market forces. the government does not interfere in exchange rate determination. This helps to reduce imports and thus helps in improving BOP position. Eg. Central bank controls money supply. Devaluation of 1991. the government will try to encourage exports and reduce imports. 2. the government intervenes in exchange rate determination. A) MONETARY MEASURES: 1.  During both inflationary and deflationary trends.e.  It is deliberate attempt by the central bank to increase the exports. Devaluation: It refers to official reduction in the value of home currency. Tariff: Tariff refers to tax or duties levied on imports which increase the import cost or makes import expensive. BHALCHANDRA KARBHARI . It also makes exports cheap and import costly. 4. This is considered to be the most important measures of correcting the disequilibrium in the BOP positions. COMPILEDBY DR. If there is high demand for foreign currency than it supply.i.  In such a situation. Control of money supply:  Central bank controls money supply to control inflation in the economy. The prices are reduced for boost exports to correct the BOP position.

WTO is the result of the Uruguay Round of negotiations (8th Round). Cash subsidy etc. . RAJESH BHOITE Page 20 PROF. GATT ceased to exist as a separate institution and has become part of the WTO. it also regulates trade in services. Not tariff and non-tariff barrier is encouraged within the functioning of WTO. which in turn would improve the BOP position.. Import Substitution:  Governments.WTO is wider in scope as compared to GATT. Not trade restrictions are expected in free trade.  It is the successor to the General Agreement on Tariffs and Trade (GATT). multilateral quota. The domestic producers may be provided with several incentives such as Tax holiday. the following are some of the export promotion measures such as duty drawback. COMPILEDBY DR.  It is the result of the evolution of the multilateral trading system since the establishment of GATT in 1947.  In addition to the regulation of global trade in goods. No member country should break Most Nations Clause (MFN).  In India. This can guarantee the removal of adverse Balance of Payment. To promote Free trade without discrimination The main objective of WTO is to promote trade without trade discrimination. which in turn would improve BOP situation. 1995. octroi refund etc. 3. 2. BHALCHANDRA KARBHARI .  The governments may encourage domestic producers to produce goods which were earlier imported. Export Promotion Measures:  The government may introduce a number of export promotion measures to encourage exporters to export more so as to earn valuable foreign exchange. and bilateral quota. especially.  The government may impose quotas on imports. It is a permanent body and it acts as the watchdog of international trade. so as to restrict the imports. 4. Quotas:  It is quantitative restriction on the volume of the goods. fright concession. excise exemption. that of the developing countries may encourage import substitution so as to restrict imports and save valuable foreign exchange. What are the objectives and Functions of World Trade Organization?  The World Trade Organization started functioning form 1st January. Q5. There are various types of quotas such as tariff quota. OBJECTIVES OF WTO: 1. intellectual property rights and investment.

To Grow the LDC’s The failure of GATT itself revealed that the developing nations were exploited in trade and were not given trading status. It provides the platform where the free trade is carried with mutual consent. It is expected that every country should enjoy equal standard of living. To Settle trade disputes It is obvious that the dispute may arise in multilateral trade. It is a administrative body for Multilateral trade among the world nations. The protection policies are not supported by WTO. The development of LDC is the prime objective of WTO. Monitors agreements: WTO monitors the world trade by framing rules and regulations to be followed by the member nations. It also administers the ‘Trade Review Mechanism’ COMPILEDBY DR. WTO supports and follows fair trade. It monitors its agreements and its implementations. To eliminate or remove the Trade barriers: WTO either eliminates or removes trade barriers to promote free trade worldwide. Seeing the environment degradation worldwide. Q6. Trade without discrimination. The sustainable development is appealed to all the members so that the future generation should not face resource scarcity. 4. The establishment of WTO aims to provide equality of status to these nations in trade. To monitor Multilateral Trade: The main purpose behind the establishment of WTO is to monitor the world trade with framing common rules and regulations for fair trade. Functions of WTO 1. There is no scope for trade discrimination under WTO. 3. It is a watchdog of the multilateral trade. 5.2. In-fact it is believed that without removing tariff and non-tariff barriers fair trade can never is carried. So WTO tries to settle this dispute by its mechanism. Forum for negotiations: It provides the forum for negations among its members concerning their multilateral trade relations. It makes trade relations good and smoothen trade with less barriers among the trading nations. The principle of WTO is to carry trade without trade discrimination among advanced and Less Developing countries. WTO has strong dispute settlement mechanism by which trade related issues are settled as and when the grievances received from any country. Unlike GATT. 2. To Raise standard of living It is one of the objectives of WTO. The gap between rich and poor nations should be removed. BHALCHANDRA KARBHARI . 3. WTO aims to protect the over exploitation of natural resources. To protect environment. RAJESH BHOITE Page 21 PROF. 7. 6.

They can be registered. COMPILEDBY DR. Q. e. names. So there is need to protect them making others not to enjoy the fruits of somebody’s efforts. films etc. In short IP can be defined as intellect possessing commercial value. The disputes occurred duet to discrimination done by any member county with trading country.7. It includes patents. indusrial designs. IPR is the rights given to the people over the creation of their minds. trade secrets and layout design of integrated circuits. Every international institute is engaged with area of its functioning. 5. 4.g. They are granted for product. Geographical indications: These are the locations of the originality of goods. Policy review mechanism: The members have to undergo a periodic review of their policies. Co-operation with other International institutions:WTO cooperates with IMF. They give right to the creator of his or her creation. computer programs and soft ware’s. It is normally an automatic right of authors and creators. BHALCHANDRA KARBHARI . geographical indications. inventive and industrially applicable. Governs the settlementdisputesWTO has strong trade dispute settlement mechanism to solve the disputes arising from the trade. This is done with a view to promoting mutual understanding of the need. 6. 2. Copyrights: A copyright is basically the right to copy and make use of literacy and artistic works. is solved by panel of experts. 4. which give the holder right to use them. Patents: These are exclusive rights granted to owners for new inventions employing scientific and technical knowledge. 3. sound recording. reputation or other characteristic of the goods which are essentially attributable to its geographical origin. trademarks. compositions. dramatic a musical creation. published edition of works. logos. 1. letters and combinations of colors used to enable the public to identify the suppliers of goods or used to distinguish the goods and services of one organization from those of other organization. process including improvements that renew. The resulting outcome of human intelligence is known as intellectual property. What are the Major Agreements of WTO? A) Intellectual Property Rights? Twenty first century is the century of knowledge. It has systematic procedure for settlement of dispute among nations dealing only with trade. It offers protection to original works of authorship in any tangible medium of expression. Trademarks: Trademarks are visual signs. IBRD and its affiliated agencies to achieve better place in global economic policy making. copyrights. broadcasts. Basmati rice (India and Pakistan).E. New ideas and inventions are being discovered every day being the outcome of human mental activity. These properties are intangible having great commercial potential. significance and the impact of these policies which would promote transparency and fairness. It indicates quality.g Coca Cola in soft drinks and Sony in electronic goods. symbols. WTO coordinates with them towards the universal welfare. RAJESH BHOITE Page 22 PROF.

3. configuration. Owners of protected design have rights to prevent manufacture. Basmati Rice. India is able to supply drugs at low prices under Indian Patent Act 1970. Impact of TRIPS: 1. Champagne (France) etc. Patenting of plant varieties would transfer all gains to MNC’s who may go for controlling food production. The patent holder would resort to imports only & national government would not be able to exercise any price control on the imported products. Impact on patent protection: It gave monopoly in manufacturing as well as import to patent holder. In India there is no separate legislation dealing with trade secrets. pattern.  Copyright 60 years  Patent 20 years  Industrial design 10 years  Layout design 10 years  Trade Mark 7 years B) Trade related Investment Measures (TRIMS) TRIMS will protect the interests of foreign investors.  The transition period given to all developing countries is five years.  Protection is also needed for India’s herbs. TRIPS extended IPRS to agriculture through patenting of plant varieties. The capital and the profits will be protected and the investee countries will have the obligation to allow the repatriation of capital and profits. 6. This has serious implications on Indian Agriculture. The foreign companies will enjoy the same rights as enjoyed by the local COMPILEDBY DR. Darjeeling tea and Kancheepuram sari. TV and textiles. Tenure of protection of IPR’s in India. It is argued that prices of drugs will increase in India due to TRIPS 2. RAJESH BHOITE Page 23 PROF. Impact on Agriculture: Indian Agriculture is troubled due to TRIPS.  The threats of TRIPS are in the field of agriculture & pharmaceuticals in India.  TRIPS are mainly needed for the promotion of technological innovation.. Industrial Designs: A design is an idea or conception as to the features of shape. Designs as applied to shoes. HIGHLIGHTS:-  India would have to fight for the protection of its plants such as Neem. pattern or composition of lines or colors applied to any article. Trade secrets: Trade secrets are defined as formula. sale or importation of article. the general opinion is not favorable to TRIPS. Impact on Drug prices: The patent regime will have adverse effects on the drug prices.g. E. BHALCHANDRA KARBHARI . 5. device or compilation of information used in ones business and gives an opportunity or an advantage over competitors who do not know the use of it. It may be problems for our farmers.  In India. Scotch whisky (Scotland). Tulsi (Basil) etc.

With regards to GATS. The units or subsidiaries of MNC freely move them form one unit to other unit regardless their nationality.  Competition for domestic firms have increased due to the well set MNC. It has resulted in brain drain.s  The money transfer is observed as outflow earned in the form of profit in our nation by foreign investors. audio visual. COMPILEDBY DR. C ) GENERAL AGRREEMENT ON TRADE IN SERVICES (GATS): GATS are based o the fact that there is growing importance of Trade in Services for growth and development of the world economy. This is expected to increase the flow of FDI (Foreign Direct Investment) and FPI (Foreign Portfolio investment) many rights have been given to the foreign investors. tourism and professional services.  Foreign investors should not be compelled to buy the local materials  They should not be compelled to export as part of their production Effects of TRIMS  The power of MNC and TNC has been increasing. Features:  All restrictions on FDI should go  The foreign investors should be treated as domestic investors  There should not be any discrimination against the foreign investors. air-transport etc. telecom. and services are defined as the supply of services from the territory of one member nation to the territory of any other member. This will provide unfettered rights the big corporations and many developing countries having less income than the companies will not have any control over the companies. They almost have taken command over the sales of their goods and services in LDCs.  The key personnel have been attracted abroad. The TRIM was introduced by USA in the eighth round of GATT at Uruguay. BHALCHANDRA KARBHARI .or domestic companies. Objective of GATS are:  To create rules for trade in services  Ensuring non-discriminatory treatment  Promoting liberal trade. It aims at establishing a multinational framework of trade in services like banking.  TRIMS provide for strong and effective protection for investors against nationalization and expropriation. insurance.  No code conduct has been seen so for TNC’s but they have been protected all the time. RAJESH BHOITE Page 24 PROF. It includes obligation of all member countries on international trade in services like telecommunication.

Negative impact of GATT:  Most of the developing countries have opened up their service sectors but finds difficult to face competition from the well developed countries.  It helps to develop professionalism and expertise in the service sector.  They lack professional skills and resources to face the global service competition. communication. It is allowed through joint venture and collaboration.g Education sector. Travel and tour sectors.Positive impact of GATT:  It provides an opportunity not only to avail services from other member countries  It helps increase the quality of its own services due to competition. BHALCHANDRA KARBHARI . hotel and hospitality. E.  Foreign firms are allowed in number of service sectors. RAJESH BHOITE Page 25 PROF. insurance.  They do not utilize their resources properly  There is brain drain of educate population to other countries COMPILEDBY DR.

Foreign exchange banks etc are . Foreign exchange market is the place where currencies are bought and sold. What is fixed exchange rate? Explain its merits and demerits 5. According to Withers “ Foreign exchange is a art and science of internationally monetary exchange.N 3 – 15) 1. RAJESH BHOITE Page 26 PROF. BHALCHANDRA KARBHARI .MODULE – III FOREGIN EXCHANGE MARKET (Q.” Foreign exchange market is a medium through which foreign currencies are bought and sold. What are the participants/players/components/ dealers of foreign exchange market 3. Explain spot and forward exchange rates 4. 2. Central Bank. This mechanism converts domestic currencies to foreign currencies. It is a mechanism to the international payments through which payments are made between two counties having different currency systems.involved in the purchase and sale of foreign exchange currencies constitute the foreign exchange market. What is foreign exchange market? Explain its functions in brief.” COMPILEDBY DR. MEANING AND FUNCTION OF FOREIGN EXCHANGE MARFKET. It includes all claims upon foreign currencies. Institutions like the Treasury. Meaning of foreign exchange: Foreign exchange refers to foreign currencies possessed by a country for making payments to other countries. Write explanatory notes on Arbitrate Hedging Speculation Q 1. According to Kindleberger “Foreign Exchange Market is a place where foreign money or currencies are bought and sold. What is flexible or fluctuating exchange rate? Explain its merits and demerits 6.

RAJESH BHOITE Page 27 PROF. BHALCHANDRA KARBHARI . International payments may be delayed as exporters and importers may not be able to fulfill their obligations immediately.Credit function has been the main drive behind the success of foreign trade. So the credit is foreign exchange markets. It is also known as money changing function of a foreign exchange market.  To cover the risk.  It leads to spot markets and forward markets. The foreign exchange market helps to transfer the purchasing power between countries. PARTICIPANTS OR DEALERS OR PLAYERS OF FOREIGN EXCHANGE MARKET. Clearing Functions:  It is the primary function of the foreign exchange market. It is needed for carrying pure trading functions. I  t helps in transferring purchasing power between two countries.Credit Function:  The foreign exchange market provides national and international credit to promote foreign trade.  While importing goods time is required for the actual delivery of the goods because of shipment and transportation of goods. Hedging will give rise to a supply of and demand for forward exchange. An importer who has to make payments to a foreign country may lose if he expects the price to rise in future.  It is important. It helps to carry out international payments and transactions.  This transfer is done by converting domestic currency into foreign currencies and vice-versa. COMPILEDBY DR. 3 .  This function plays an important role in promoting international trade along with international capital flow.Hedging Functions:  Hedging means covering foreign exchange risks arising out of fluctuations in exchange rates.1. 2 . he may deposit his own funds in the foreign country or buy forward the foreign exchange. as it permits exporters and importers to protect themselves against risks connected with exchange rate fluctuations. Q2. especially in a market with flexible exchange rates.  Bills are discounted for this purpose.

2.  Being more in number these banks provide good services for these markets.Acceptance house:  They also participate in foreign exchange transactions.  These include people. the central bank of the nation normally does not interfere in the exchange market. 3.  They are large in numbers.  They accept bills of exchange on behalf of the clients and increase the scope for such market transactions. The main role in this regards is played by foreign exchange brokers. RAJESH BHOITE Page 28 PROF. Their role is important in the success of these markets. Demand and supply of foreign exchange is influenced by retail clients.Central banks:  It is the main official player of this market having power to control the transactions of foreign exchange markets.  Commercial banks help in assisting foreign trade and foreign exchange transactions. COMPILEDBY DR.  They deal through commercial banks and authorized agents.  But now they are interfering in the same to influence the rates in order to keep economy unaffected by the trade.  They authorize commercial banks and other financial institutions to deal in foreign exchange.  They are middlemen who get commission and save time of banks. They deal with other commercial banks and also through foreign exchange brokers.1. BHALCHANDRA KARBHARI .  They do not sell or buy currencies themselves.Retail clients. 4 Brokers:  They are the authorized brokers acting as intermediaries between buyers and sellers.  They are so called ‘Authorized Dealers’ Under the fluctuating or flexible rate system. 5. The initiative is needed for controlling inflationary and deflationary trends. international investors. multinational corporations and others who need foreign exchange. Commercial banks:  They carry out buying and selling orders from their clients.  Their role is major in the success and spread of foreign exchange market.

say a dollar. SPOT AND FORWARD EXCHANGES The term spot exchange refers to the price of foreign currency in terms of domestic currency payable for the immediate delivery of the foreign currency. The rate of exchange effective for the spot transaction is known as the spot rate and the market for such transactions is known as the spot market. RAJESH BHOITE Page 29 PROF. They are different than spot exchange rate because it may either be at premium or discount or par: At par: If the FER quoted is exactly equivalent to the spot rate at the time of making the contract. The FER for a currency. They are appointed by banks because they possess more knowledge or information about the market. the foreign rate is said to be at a premium. the settlement takes place within two days in most markets. 60 or 90 days or may be for a year (180 days). obviously. Forward exchange facilities. against payment in domestic currency by the other party.  They are: Wholesale market known as inter-bank market has size of transactions very large. In practice. This rate is agreed upon the demand and supply forces in the currency market. is said to be at a premium with respect to COMPILEDBY DR. the forward exchange rate is said to be at par. Non-bank financial institutions:  Due to deregulation and liberalization of financial markets during recent years. or exchange of currencies on the spot. at the price agreed upon in the contract. requiring the delivery at some specified future date of a specified amount foreign currency by one of the parties. It is day to day rate of exchange which is charged on the delivery of goods on spot. Q3. The forward transaction is an agreement between two parties.  Brokers who act as middlemen between the prices makers. These contracts usually have maturities of 30. It is the class of foreign exchange transaction which requires the immediate delivery. It includes highly professional dealers and MNC banks. At premium:If the forward rate is above the present spot rate. The rate of exchange applicable to the forward contract is called the forward exchange rate and the market for forward transactions is known as the forward market. are of immense help to exporters and importers as they can cover the risks arising out of exchange rate fluctuations by entering into an appropriate forward exchange contract.  Foreign exchange transactions are handled by these institutions on a large scale. BHALCHANDRA KARBHARI .6. Etc. non banking institutions are getting to scope to participate and provide services in these markets.

conversely. Then arbitrageurs buy dollars in US dollars from US market and sell it in the Indian market and gets profit of Rs 5/. Example: Suppose if the rate of exchange is 1US $ = 50/. RAJESH BHOITE Page 30 PROF. the forward rate will be quoted at premium  And.  When the supply is equivalent to the demand for forward exchange. Those who deal with arbitrage are called Arbitrageurs’. It is also true that arbitrage never deals with such operations if the profit margin is low. At discount: If the forward rate is below the present spot rate. the forward rate will tend to be a par. say rupee.the spot rate when one dollar buys more units of another currency. Write a note on Arbitrage Arbitrage means: “ The purchase of securities on one market for immediate resale on another market in order to profit from a price discrepancy (discrepancy). They purchase currency in a low price market and sell in higher price market immediately without involving any risk. when the demand for forward exchange exceeds its supply. Q4. COMPILEDBY DR. Arbitrage involves buying and selling of foreign currency in low markets in order to gain profit from the price differences between the two markets. It is possible within the country or within the local market where two banks offer two different bids and asking rates. the grab opportunities immediately because the difference in exchange rates in tow markets may be for a short period of time due to the difference in demand and supply faced by different banks or traders in foreign exchange.per dollar. Arbitrageurs’ may be banks. the rate will be quoted at discount. when the supply of forward exchange exceeds the demand for Indian markets. BHALCHANDRA KARBHARI . He enjoys the difference of same currency values existing in different US market and 1 US $ = 55/. in the forward that in the spot market. The foreign exchange rate is said to be at a discount.  Naturally.

increase local currency borrowing. Q5 Write a short not on -HEDGING:-  The exchange rates frequently fluctuate and the exporters may suffer loss.000.  Triangular Arbitrage: The process of buying and selling foreign exchange between three different currencies in order to profit from a discrepancy in cross rates. exporter may gain.  It is an important function of foreign exchange market. But due to certain uncertainty of the market situation. If the local currency is expected to appreciate. usually the firms who enter the forward exchange market to protect themselves against the risk arising out of exchange rate fluctuations. Hedgers are the agents. delay accounts payable and sell weak currency forward. It occurs when three currencies are involved. speed up the collection. If the payments are to be made in future then it may be a great loss to the exporter or the importer. reduce imports of soft currency goods.  They guarantee payments of foreign exchange at a fixed rate. This is called hedging. When the rates become favorable. Let understand its function. E. delay remittance.00. through an agreement with commercial banks or authorized agents. The spot rate at the moment is Rs. The strategy of hedging involves increasing hard currency which is likely to appreciate and decreasing soft currency which is likely to depreciate and at the same time decreasing hare currency liabilities and increasing soft currency liabilities. BHALCHANDRA KARBHARI .Types of Arbitrage:  Geographical Arbitrage: In trading practice of buying a currency in once geographical market and selling it in another in which the price is higher. speed up remittance of dividend to the parent company. decrease accounts receivables. He will have pay more than spot rate determined. If depreciation of Indian rupee is expected the basic hedging strategy would be: reduce the level of cash rupees.g. then the hedging strategy would be to increase the stock of local currency. speed up all the payments to be done in hard currency and delay al the receivables from abroad. 40=$ 1. even if the exchange rates might have gone down or up. reduce local currency borrowing. 20. It consists of buying currency where it is the cheapest and selling it where it is the dearest so as to make a profit from the difference in the rates. buy currency forward.  So foreign exchange market provides hedges against such fluctuations. So he may enter into buying dollar forward today. COMPILEDBY DR. if the importer fears a depreciation of rupee.  It is the risk management technique against the fluctuations observed in the foreign exchange rates. RAJESH BHOITE Page 31 PROF.000 has to make the payments in three months time. Then he has to pay Rs. It has scope in International banking and finance. Suppose an Indian importer who imports goods from America worth $50.

Speculation means “taking of foreign exchange risk or an open position in the hope of making profit. It is observed in the forward market.  Speculation in a foreign currency depends on domestic and foreign interest rate differentials and on expectations about future movements in the exchange rate. Q5. Short hedge : An investor already owns a spot asset and engages in a trade to sell its associated future contract. and then he buys the foreign currency in the forward market. He sells it’s at the spot exchange rate after 3 months.Importance: 1. If his expectations are correct. It is forward contract. 2. It is based on the expectations about the future rate of the foreign currency. It is the risk management technique. 2. COMPILEDBY DR. RAJESH BHOITE Page 32 PROF. Speculation may be. Suppose the interest rate in the foreign market is higher than in home nation. It is also called selling hedge. It provides at least partial protection an order at a fixed price. . Speculation and its types  The supply of and demand for forward exchange market is also the result of speculation. It provides at least partial protection for securing future supply at a fixed ceiling price. he earns a profit or he may incur a loss or break even. It is also called buy hedge or purchasing hedge. It saves importer as well as exporter from the risk going to arise due to the fluctuations in the exchange rate. 4. Long hedge or Anticipatory hedge : An investor is protected against adverse price movements of an asset that will be purchased in the future. 3.  Suppose a speculator who expects the spot rate of a foreign currency to increase in relation to his home currency in say 3 months. Types: 1. BHALCHANDRA KARBHARI . It is good for the firms who have large amounts receivables or commitments to pay in foreign currencies.

Since investors are assured of regular returns. Thus they get no profit and may stop speculative business. No speculation: Being fixed in nature. Q6. BHALCHANDRA KARBHARI . MERITS: 1. 2. the rate is not determined by the market forces but it is pegged/fixed. It also supports the growth of money and capital markets. thereby earning a profit. when speculators sell a foreign currency with a fall in the exchange rate in the expectation that it will fall further. when they sell a currency with a rise in its exchange rate in the expectation that it will soon fall.Government follows exchange control to keep the rates stable. COMPILEDBY DR. Under this system. Destabilizing : When speculators buy a foreign currency with a rise in the exchange rate in the expectation that it will rise further. It helps to reduce the exchange reserves. Stabilizing : When speculators buy a foreign currency with a fall in its exchange rate in the expectation that it will soon rise and thus earn a profit. The effect of such speculation is to smooth out fluctuations in the exchange rate. (Buying and selling exchange at a particular rate). RAJESH BHOITE Page 33 PROF. 1.The fixed exchange rates creates certainty and assurance in the trade. Certainty in the rates is highly featured in this method. This rate is fixed by the government by means of pegging operations. 2. In contrary. FDI is encouraged. 3. international trade is promote without any speculation and forcasting. there is no chance to speculate the fluctuations in the exchange rates. WHAT IS FIXED EXCHANGE RATE? ITS MERITS AND DEMERITS: This is the system where the exchange rate is fixed and found rigid irrespective of changes in the demand and supply of exchange. It is the feature of IMF agreement. Promotes trade: As the exchange rates are stable. On the other hand. FDI: Fixed exchange rates ensure the regular flow of the international capital movements.

it systematized the worlds monetary system. It minimizes risk. Not permanent: It is not possible to keep exchange rate fixed because it may deter the long term investment. 6. 2. A stable exchange rate helps to achieve internal economic stability and avoids problems of hoarding. There is also a problem of division of power between the two authorities to maintain fixed exchange rates. Lacks adjustment mechanism: The greatest defect of the system is that it lacks adjustment mechanism. DEMERITS: 1. COMPILEDBY DR. 7. decline in investment and unemployment. Simple and systematic: The economic transactions between nations have become too complex that it is advantageous to follow a fixed exchange rate system. Hence there had to be variations in exchange rates. It is difficult to respond to temporary shocks. BHALCHANDRA KARBHARI . 5. Stability. It is found in the flexible exchange rates. It would be very difficult in the fluctuating exchange rate system. Controls inflation: Fixed exchange rate helps to maintain the external value of the currency stable and thus controls inflation. Rigidity: This exchange rate has been found more rigid and thus may create problem in promoting international trade. Difficult in real sense: This system has to be supervised by an authority of the national government and international authority.4. 4. Problem of liquidity: It creates problem of liquidity. This puts a great strain on the reserves of participating countries. Good for small countries: Fixed exchange rate system is good for the small nations as their transactions are small and need highly certainty and surety. 5. For example an oil importer may face a balance of payment deficit if oil price increase but in a fixed exchange rate there is little chance to devalue. 3. RAJESH BHOITE Page 34 PROF.

such a system discourages long-term foreign investment which is considered available under the really fixed exchange rate system. It does not require the use of exchange control which may be necessary under the fixed exchange rate system. its exchange rate relative to other currencies increases.Easen liquidity problem: As exchange rate moves freely. If there is a high demand for a particular currency. This system is quit suitable for the countries like USA.6. 5. the external value of the currency’s fall. Q7 . 4. Therefore.This rate is set where the demand for exchange and supply of exchange is in equilibrium. on the other hand. It encourages export and discourages imports and thus automatically brings equilibrium in the BOP. When there is deficit in the BOP. Exchange rate is determined according to the free forces of demand and supply of foreign currencies. So a prolonged disequilibrium is automatically avoided. BHALCHANDRA KARBHARI . 3. 2. Avoids prolonged Disequilibrium: The flexible exchange rate system facilitates continues adjustments. Full employment: Flexible exchange rates reflect the true cost-price structure relationship. there is no need to maintain large scale reserves. 6. if there is less demand. The exchange rate changes freely to equate demand and supply and the problem of scarcity or surplus are automatically solved. In this system exchange rate go on fluctuating according to the demand and supply of it in the world market. COMPILEDBY DR. The flexible exchange rate system solves the problem of international liquidity automatically.Discourage Foreign Investment: Fixed exchange rates are not permanently fixed or rigid. It is good under the multilateral trade system. Explain the flexible exchange rate system? Its merits and demerits. its value decreases. They are more suitable to countries seeking to follow a policy a full employment. MERITS: 1. Smooth adjustment: Flexible exchange rate brings smooth adjustment in BOP position automatically. Free trade: Flexible exchange rate promotes free trade. RAJESH BHOITE Page 35 PROF. Automatic: This system is quite simple.

On the other hand. Due to increasing risks. Instability and uncertainty: The flexible exchange rates lead to instability and uncertainty. such a system causes large-scale capital outflows and inflows. 3. long-term investments are curtailed. BHALCHANDRA KARBHARI . 2. It leads to BOP problems in the country if the value of currencies rises externally. seriously disturbing the economy of the country. RAJESH BHOITE Page 36 PROF. By encouraging speculative activities. COMPILEDBY DR. 8. Unsuitable: This exchange rate is unsuitable if the factors are immobile. in turn.Factor Immobility: The immobility of various factors of production deprives the flexible exchange rate system of its advantages arising from the adoption of monetary and other policies for maintaining internal stability. Such policies produce desirable effects on production and employment only when supply of factors of production is elastic. It is also not good during the war situation and political instability. thus. Speculation: Under this exchange system there will be more speculation causing further fluctuations. the fixed exchange rate system prevents inflation and maintains the external value of currency.Unnecessary Capital Movements: The system of fluctuating exchange rates leads to unnecessary international capital movements. BOP problem: Due to uncertainty in the rates. 5. 4.Adverse Effect on Economic Structure: The system of flexible exchange rates has serious repercussion on the economic structure of the economy. destabilize the economy of the country. elasticity’s of demand also get affected in the foreign market. 6. 7. This reduces the volume of investments and international trade.DEMERITS: 1. Fluctuating exchange rates cause changes in the price of imported and exported goods which. Inflationary: This exchange increase in inflationary pressures on the domestic price level causing further depreciation.


communication. 3. Explain Purchasing Power Parity theory? (PPP theory) 3. 2 Import of services: Nowadays the service sector is booming worldwide. So the demand for the same has been increasing nowadays. OR Explain the factors affecting exchange rate. investment in financial assets or direct investment. Such payments may be a part of foreign aid or social help. banking. So exchange is needed to fulfill the same requirements. Explain the determinants of foreign exchange rate? Or factors affecting exchange rat 2. It is the price or one currency in terms of another currency. RAJESH BHOITE Page 38 PROF.15 marks) 1. The foreign exchange rate is the rate at which the currency of a country is exchanged against the currency of another country. The exchange rate is determined by the interaction of demand and supply of particular currency.MODULE. It expresses one currency in terms of another currency. Say 1$=45/-Rs. Determinants: A) Demand for exchange: 1. Therefore the services are in great demand in worldwide. Import of goods: It is the major part of total imports. Demand for such exchange depends on the prices of the imports.Export of capital: Foreign exchange is required for the repayment of debt. Explain managed flexibility (LERMS) OR central bank intervention in exchange rate. donations are to be made in foreign exchange. transport tourist services and educational services demands foreign exchange. Capital goods and consumer goods are imported from other countries. Higher the prices of imports lesser the demand for foreign exchange and vice versa. COMPILEDBY DR. purchase of assets in foreign countries. Explain the role of central bank (RBI) in foreign exchange determination 5. n. So the demand has been continuously increasing for the same. Therefore the exchange is demanded by the people who import these goods.4. BHALCHANDRA KARBHARI . Critically explain PPP theory 4.Unilateral payments: Sometimes rich nations do support LDC’s with foreign aid so the payments such as gifts. Q What is Foreign exchange Rate? Explain its determinants. Services rendered by the other countries which include insurance.IV EXCHANGE RATE MANAGEMENT (Q. 4.

The supply sterling pounds depends on the Britain’s demand for India’s goods. It is also needed to make the payment of external borrowings. all constitutes and increase the supply of foreign exchange. So they are paid Interest.5. The supply of foreign exchange is influenced by size and price of exports . tourists coming from other countries. finance and insurance are some of the important services which supply the foreign exchange. Export of goods: This is a major source of supply of foreign exchange. RAJESH BHOITE Page 39 PROF. repayment of debts by the foreigners. Expert services in various fields. Dividend and Profit in their currencies. This source is gaining importance in recent years. donations given and all types of receipts. 2 Export of services: Exports of services are also the source of supply of foreign exchange. Remittances: Most of the foreign firms or individual investors (Foreign Portfolio Investment) are investing in India. B) SUPPLY OF FOREIGN EXCHAGE: 1. Communication.Both the size and price of exports depends on demand of elasticity for exports. transport. 3 Unilateral receipts: It includes payments received in the form of remittances made by domestics working abroad. BHALCHANDRA KARBHARI . COMPILEDBY DR. It creates the demand for foreign exchange. 4Import of capital: Foreign Direct investment ( FDI) and Foreign Portfolio Investment (FPI) . Supply from all these sources add up to aggregate supply of foreign exchange Determination of exchange rate where demand and supply of currencies are same.

This theory has been restated by the Swedish economist Gustav Cassel in 1916. the exchange rate between one currency and another is in equilibrium when their domestic purchasing powers at the rate of exchange are equivalent. Remittances: Investment done by Indian firms or individual investors brings foreign exchange. DIAGRAM Q PURCHASING POWER PARITY THEORY. According to him “ the rate of exchange between two currencies must stand essentially on the quotient of the internal purchasing powers of these currencies.g.”Thus.5. The rate is fixed where quantity demanded for foreign exchange get equal to quantity supplied of foreign exchange.’ COMPILEDBY DR. E. according to the purchasing power parity theory. when the exchange rates were free to fluctuate. if in India 45 Rs are spent for purchasing 1 kg of apples and in America for the same kg of apples if one dollar is needed to spend. exactly in the years following the First World War. interest received and profit earned. EQUILIBRUIM EXCHANGE RATE The exchange rate is determined where demand for and supply of foreign exchange becomes equal. the rate of exchange between two currencies in the long run would be determined by their respective purchasing powers. BHALCHANDRA KARBHARI . In order to make equivalent these currencies with each other’s units purchasing power will be 1$ = 45Rs. then it is clear that the purchasing power of both currencies is different in their respective nations. Inflow of foreign exchange is the result of such investment in the form of dividend received. So’ the relative purchasing power of the two currencies is the main determinant of the exchange rate between them. RAJESH BHOITE Page 40 PROF. Even income earned on lending constitutes supply of foreign exchange.

In this new equilibrium rate of exchange can be COMPILEDBY DR. 2. It is calculated as: Rate of exchange = PI / PA Where. If there is a change in prices (purchasing power of the currencies). 2 when they purchase a commodity worth $ 1. Absolute Version: Under this version. dollar holder will convert dollars into rupees because. the market forces will operate to restore the equilibrium if there are some deviations. RAJESH BHOITE Page 41 PROF.g. then the purchasing power of rupee in terms of dollars would decline. It is not easy to measure the value of money in absolute terms. Thing to note is that. say USA. by doing so. BHALCHANDRA KARBHARI . if the exchange rate changes to 1$ = 42Rs when the purchasing power of these currencies remain stable. A change in the purchasing power of currencies will be reflected in their exchange rates. the new equilibrium rate of exchange can be found out by the following formula.Once the equilibrium is established. E. ER = Er X Pd/Pf Where. they save Rs. Relative version: It is brought over improving absolute version which is not good measure due to neglect ion of transport cost and trade restrictions. Hence the changes in the equilibrium rate can be measured by the ration of the price indices of the respective countries. It reflects their domestic purchasing power too. the exchange rate between the currencies of two nations is established at the point where their purchasing power is equal. In this method the changes in the purchasing power can be measured by the changes in the indices of domestic pricesof the countries concerned.  PI = Prices of certain goods in India or domestic currency  PA = Prices of same goods in another country or foreign currency. If inflation is India. For this purpose the price index is made. the changes in internal price level cause changes in the exchange rate. ER = Equilibrium exchange rate Er =Exchange rate in the reference period Pd = Domestic price index Pf = Foreign country’s price index Two versions of PPP: 1. It is the parity (equality of the purchasing powers of the currencies which determines the exchange rate.

But in reality.calculated by multiplying the base period of rate exchange by the relative changes in the price levels in the two countries with the help of index numbers. capital transfer. Ans:-The PPP Theory has the following limitations- 1) Limited Application to large Countries: The PPP theory is applicable mainly to the small countries and not large countries.3) Explain the limitations/ Critical Evaluation of the purchasing power theory. There is a difference I the quality of goods. 2) Ignores Specializations in International Trade: This theory ignores the effect of specialization in international trade. Q. 3) Direct not possible: In the PPP Theory we assume that the changes in price levels results in changes in the exchange rate. But in practical sense direct link between price change and exchange rate may not exist. 5) Transfer of Capital is neglected: The applicability of this theory is limited. Trade in service. It considers only the trade in merchandise. All such items also create a demand for and supply of foreign exchange. 4) Ignores Government Intervention in Exchange Rate: The theory assumes free trade and absence of exchange control for a steady rate based on PPP. It is applicable to countries where major portion of their national income comes from international trade. Short run applicability is more significant. COMPILEDBY DR. 6) Long Run Application: This theory ignores the effects of economic variables in the But this theory does not consider this difference in quality of goods . and unilateral transfers are excluded. Normally countries specialize in those items in which they enjoy superior cost a vantage. and accordingly produce for goods for domestic consumption as well as exports. BHALCHANDRA KARBHARI . RAJESH BHOITE Page 42 PROF. Therefore the theory holds good only in the long run. 7) Ignores the Quality of Goods: The quality of goods in different countries may not be the same.

Hence the theory s not dynamic in nature. Authorized dealers: Under the supervision of Central Government. 3. BHALCHANDRA KARBHARI . Regular directions: RBI issues direction through “Exchange Control Manual’ time to time regarding Imports and Exports. all payments for imports have to be made only through authorized dealers. The items like Gold can only be exported with proper due permission of RBI. Q Role of Central bank or RBI in controlling foreign exchange in India. Today’s world has become highly dynamic. 5. RAJESH BHOITE Page 43 PROF. Even the negative list of exports is prepared by Government Of India. Due to some factors the demand for a commodity in the domestic market may be highly elastic. It is covered under the scope of Industrial Policy of the Government of India. It is the movement of capital and speculative activities which have a deep impact on the exchange rate. Rate fixation: RBI has the right of fixing the value of home currency which is known as the official rate of exchange. 2. 9) Elasticity o Reciprocal Demand is Ignored: This Theory does not consider the elasticity of a commodity in two countries. Return submission: Authorized dealers must report all foreign exchange transaction to the RBI enabling to keep an eye on it regularly. According to Foreign Exchange Regulation Act (FERA) was passed in 1947 the role of RBI toward intervening foreign exchange market operations is 1. 6. This way RBI regulates import trade. Imports are only permitted against proper licenses and according to FERA. 7. These directions are very useful for currency control. Exchange stability objective of RBI only can be achieved when reported with each and every economic transaction carried by dealers. 8) Not a Dynamic Theory: This theory I applicable to a static world. Controlling FDI and FPI: Investment in India can only be done by Non-residents after obtaining the permission of RBI. And every one dealing with it is expected to follow it unconditionally. Foreign Travel remittances. The norms related to it have been given in FERA now replaced with FEMA. It is the administrative authority for exchange control in India. Transfer of Investment incomes and transfer of capital. 4. Nowadays in order to attract more Foreign Direct Investment and Foreign Portfolio COMPILEDBY DR. Controlling Exports: The RBI also controls export trade with the help of custom authorities. Restricting Imports: There are norms and proper rules which are to be followed while importing goods from out. RBI has appointed to authorize to issue licenses to those who wish to get involved in foreign exchange transactions.

Indian Rupee was pegged to dollar and basket currencies of India’s major trading partners. Government has been framing liberal policies where flow of Investment is permitted in particular sectors. The RBI has been given powers to issue licenses to those who are involved in foreign exchange transactions.Liberalized Exchange Rate Management System. Issue of Directions: The ‘Exchange Control Manual’ contains all directions and procedures given by RBI to Authorized dealers from time to time.4 Explain RBI’s intervention in exchange rate management in India. India adopted exchange rate of IMF up to 1971. 3. Between the periods of 1971 -1992. Investment. In 1992. RAJESH BHOITE Page 44 PROF. Import is permitted only against proper licenses. Q. Under it dual exchange rate was. To conserve the foreign exchange reserves which is scarce in nature? RBI’s Role: 1.40% of foreign exchange earnings to be surrendered to RBI at official exchange rate and 60% of foreign exchange earnings to be converted into Indian Rupees at market determined exchange rate. To promote economic development by the way of import substitution and export promotion. RBI introduced LERMS. 3. From 1994. LERMS was withdrawn and all transactions of goods and services were converted at market rate with no restrictions. Even outflow of capital has been allowed through Joint Venture. Administrative Authority: The RBI is the administrative authority for exchange control in India. COMPILEDBY DR. To maintain stability in exchange rates 2. BHALCHANDRA KARBHARI . The main objective of RBI in Indian Foreign Exchange market: 1. Import Trade: RBI regulates import trade. 2. The items of imports that can be imported freely are specified under open general license.

The central bank intervenes in exchange rate determination. foreign currency appreciates and domestic currency depreciates and vice-versa.  Suppose there is much demand for foreign currency say US dollar in the Indian market. If central bank expects increase in demand for foreign exchange. Therefore RBI. Under managed flexibility the central bank intervenes to bring stability in the exchange rate. There are disadvantages of such system also so the nation like India has adopted Managed Flexible Exchange Rate(MFER). Under this system if the demand for foreign currency is more than that of its supply. RBI releases the dollars from its reserves in the market so as to stabilize the exchange rate of Rupee-dollar. So RBI needs to intervene when there is inflationary or deflationary trends market. Nowadays relaxation has been provided on such exports. Export Trade: The RBI controls export trade. These rate was determined by the market forces ofdemand and supply of currencies. 3. it may accordingly plan to intervene to release more foreign exchange reserves in the market so as to influence the exchange rate. Normally central banks do not interfere in such determination. Attempt is COMPILEDBY DR. which means they adopted the flexible exchange rate. 4. Economic adjustment: Frequent change in exchange rate may create a problem in Balance of Payment position. it helps to bring exchange rate stability. purchases the dollars from the market so as to bring about stability in the Rupee-dollar rate. Proper control: Change in exchange rate may affect imports or exports unfavorably. dollar will appreciate too much and Indian Rupee will accordingly depreciate. BHALCHANDRA KARBHARI . too much appreciation of Indian Rupee adversely affects exporters.  Suppose if there is less demand for foreign currency say US dollar in Indian market. dollar will depreciates and Indian Rupee will appreciate too much. RAJESH BHOITE Page 45 PROF. The special permission of RBI is needed for exporting Gold and Jewellery. But after they allowed the market forces to determine the exchange rate. Therefore intervention of RBI in stabilizing exchange rates helps to improve the condition of the same or avoid such disturbances. It was automatic operation. Managed Flexibility: Developing countries initially followed fixed exchange rate system under IMF condition. Significance of managed flexibility: 1. Appropriate rate: The RBI goes on collecting market information or keeps an eye over the foreign trade and currency issues. Depreciation of Rupee adversely affects Indian importers and the problem of excess demand for dollars. 2. RBI intervene by purchasing foreign currency form the market or sale of foreign currency in market.

two goods.6 OBJECTIVES (FOR INTERMAL MODULE 1 and 4) & FOR FINAL EXAM ALL) Questions to be studied:  Explain comparative cost advantage theory of Ricardo OR Ricardian theory  Critically explain comparative cost advantage theory  Explain modern theory/factor endowment theory/factor abundance theory or Hechshcher Ohlin theory of international trade  Critically explain modern theory of international trade. It helps monetary authorities like RBI to bring control over economic activities.S. one factor LABOUR Comparative cost theory  Ricardo (Comparative cost benefit over one (Classical theory) commodity  Model: 2x2x1  Two nations. It only conserved QUANTITY exported and concept imported Net Barter Terms of Trade It only considers PRICE of goods exported and imported concept Income Terms of Trade concept Given by DORRANCE. two factors LABOUR AND CAPITAL Terms of trade Shows Relationship between Export price and Import price Gross barter Terms of Trade Given by TAUSSIG. one factor LABOUR Factor Endowment theory  Heckscher-Ohlin ( based on Two factors with intensity) (Abundance theory/ Modern  Model is: 2x2x2 theory)  Two nations. one good. advocated by Reciprocal demand curve (Offer Advocated by Marshall and Edge worth Curve)/International demand COMPILEDBY DR. It considers both PRICE AND QUANTITY Theory of Reciprocal demand is J. SEMESTER. Mill showing equilibrium rate of exchange. BHALCHANDRA KARBHARI . made not to save importers and exporters form the risk arising from the fluctuations exchange rates.  What is a term of trade? Explain factors affecting it  Explain the types of Terms of Trade in detail  Explain Gains from trade and factors affecting it(determination)  Explain importance of Gains from trade ( with Offer curve)  MODULE-I INTERNATIONAL TRADE question Answerers Absolute cost theory is given by  Adam Smith (Specialization)  Model is: 2x1x1  Two nations. RAJESH BHOITE Page 46 PROF. two goods.

1947 set up  Replaced with WTO in 1995 COMPILEDBY DR. Depreciation : ( automatic fall in currency value by market BOP forces) 2. Foreign aid. RAJESH BHOITE Page 47 PROF. Gifts Reserve Account shows Gold sold or purchased What is BOP disequilibrium? Surplus or Deficit When Import >Export = Deficit Export>Import =Surplus Cyclical disequilibrium Due to trade cycle phases like recession.curve Offer curve is based on PRICES of two commodities/ \ MODULE – II BOP AND WTO Questions to be studied:  What is BOP? Explain its structure  What are the types of BOP disequilibrium  What are the cause of BOP certificate  Explain the measures for BOP disequilibrium  Explain BOP trends after 1991. depression. BHALCHANDRA KARBHARI . Deflation( fall in prices) Non-monetary measures Quantitative restrictions imposed ( Volume restricted) General Agreement on Tariff and  Ad-hoc agreement for trade for multilateral trade Trade (GATT)  Year. prosperity Short run disequilibrium Due to excess borrowing Long run disequilibrium Due to discrepancy between savings and investments Structural disequilibrium Due to change in taste and economic sectors Fundamental or Chronic Defined by IMF for serious BOP problem Disequilibrium Monetary Measure of correcting 1.  What is WTO? Explain its objectives and functions  Explain WTO agreements:  TRIMS  TRIPS  GATS Balance of trade shows  Only VISIBLE AND merchandise goods  It shows deficit or surplus Balance of trade shows  Visible + invisible goods(Services)  It shows either omission or Error  It is based on Double entry book keeping system Current account shows Goods and services exported and imported Capital account shows Capital flows (FDI/ FPI/ investments) Unilateral account shows Receipt and payments of Donations. Devaluation: (currency value is deliberately reduced by monetary authority(RBI) 3.

Fixed exchange rate  Traced to Gold standard later stage  Rigid and certain  Brings pressure on reserves  Good for small nations  Role of monetary authorities is important Flexible exchange rate  Floating or fluctuating rate system COMPILEDBY DR. RAJESH BHOITE Page 48 PROF. layouts. industrial designs. BHALCHANDRA KARBHARI . trade secrets etc. 1st January (WTO)  Encourage multilateral trade  Tariff and quota reduction  Dispute settlement mechanism Trade Related Intellectual Under this agreements KNOWLEDGE is protected by Patents.World Trade Organization  Replaced GATT in 1995. Trade related Investment Under this agreements INVESTMENTS encouraged measures’ (TRIMs) General Agreement on Trade in Under this agreement services are liberalized. Property Rights (TRIPs) copyrights. Spot rate The rate at which immediate delivery of foreign exchanges take place Forward rate The rate which future transactions are carried on agreed rate of exchange. services (GATS) MODULE – III FOREIGN EXCHANGE MAREKT  What is foreign exchange market? Explain its functions  What are the players or components or elements or dealers of foreign exchange market  What is spot and forward exchange rate system  Explain merits and demerits of fixed exchange rates system  Explain merits and demerits of flexible exchange rate system  Explain in detail  Arbitrage  Hedging  Speculation Foreign exchange Currencies dealt in trade Foreign exchange market Place where exchanges are bought and sold Clearing function Transferring purchasing power (Currency conversion Speculation Anticipating changes in currency values Hedging Provides Risk cover arising due to currency value fluctuations Arbitrage Function of earning profit by selling currencies from low price markets to high price markets.

 RBI intervenes by selling or buying exchanges  India has adopted this rate system Who propounded PPP theory Gustav Cassel What PPP theory says? Parity/ equality of purchasing powers of the currencies determines exchange rates Foreign exchange Regulation Act Passed in 1947 to control foreign exchange transactions Foreign Exchange Management Act Replaced FERA in 1999 Liberalized Exchange Rate management Brought in 1992 for dual exchange rate system System( LERMS) COMPILEDBY DR.  Explain role of RBI in controlling foreign exchange rate  Explain intervention of RBI in exchange rate or Managed flexibility OR LERMS Exchange rate It is a rate at which currencies are exchanged Managed Float system  Hybrid of fixed and flexible rate system.  Rate is determined by market force s of demand and supply factors  No intervention of RBI  It does not put pressure on reserves MODULE – 4 FOREIGN EXCHANGE RATES  Explain the determination of foreign exchange rate? OR How foreign exchange rate is determined – explain with diagram  Explain PPP theory in detail with its types  Criticism of PPP theory. BHALCHANDRA KARBHARI . RAJESH BHOITE Page 49 PROF.